Bottom Shekel / You Did It Once Before. Should You Save the Economy?

It was 25 years ago to the day. On Friday, October 7, 1983, the Israel Radio news anchor began the 7 P.M. program with a dramatic announcement: Trading in bank stocks had ceased. The Tel Aviv Stock Exchange had shut down and would only reopen after an arrangement had been reached over the shares.

The news was greeted with cries of fear and rage up and down the land: They screwed us again, people wailed. We're about to lose everything we invested in the safest thing there is - bank stocks.

At the time, the banks' values reached insanely bloated proportions, because the bankers were manipulating the share prices. They called it "adjustment," but it was pure, criminal manipulation of stock prices.

That Friday, the people learned that foreign banks were refusing to continue to fund the "adjustment." In English, they wouldn't lend Israel's banks any more money to buy more bank shares. Bank stocks started to hit the market in enormous amounts - $300 million worth a day.

Just to demonstrate how ludicrous the proportions had become - Bank Leumi was trading at a higher market capitalization than Chase Manhattan.

The bankers, realizing they couldn't manipulate the market anymore, gave up and reached an agreement with the Finance Ministry and Bank of Israel.

For Israel, that crisis was bigger than the present one. There was real fear that if the bank stocks crashed, giant companies would collapse with them, because collateral backing their loans had been invested in bank shares. So once the manipulation ended and Israeli bank values returned to their natural size, the banks had to recall loans, and the companies couldn't pay. They would go broke and after them so would the banks, leading to total economic collapse.

To avoid that horror scenario, the TASE closed for two weeks. That time was used to reach the "bank shares arrangement," which turned $7 billion worth of shares into dollar-denominated bonds issued by the state. The banks were, in effect, nationalized.

It was you, the taxpayer, who rescued the banks and economy from bankruptcy. It was you who saved holders of bank stocks, too, because there was a tremendous transfer of capital from the taxpayer to the shareholders.

The price the taxpayer paid was heavy, but the rescue plan worked. It prevented a crash that would have resulted in a deep, horrible depression.

Does that mean that now the government should shove its hand into your pocket, you the taxpayer, and use your money to buy up the corporate bonds that are dropping like stones on the Tel Aviv Stock Exchange?

Today's situation is completely different. The issue today isn't whether Israel's banks will collapse, resulting in depression. Israel's banks are not in danger of collapse. They aren't going broke. Your deposits at the banks aren't in danger and there are no worries about a deep, protracted recession. Even if Lev Leviev, Eliezer Fishman and Yitzhak Tshuva stumble, the banks will not fall.

The ones in trouble are the real estate companies that issued bonds and used the money borrowed from the public to buy properties in Russia, Florida and other exotic sites. They undertook substantial risks, borrowed enormously, and bought properties at top dollar. Now the value of their properties is dropping, they're posting losses and are choking as liquidity dries up, because they're having trouble recycling old loans.

That's no reason for the government to lay out a safety net. When the tycoons were making their billions and their shareholders were applauding, were they sharing profits with the taxpayer?

Intervention now would amplify the "moral hazard." Investors would grasp that they can take excessive risks in the future, too, once the crisis is history, because at the end of the day Jerusalem will ride to the rescue. And that rescue lays the seeds of the next crisis.

In 1996 the government intervened again as provident funds crashed, buying up bonds on the stock market. Why shouldn't it do so again?

Again, the 1996 story is a different one. It happened in mid-1996, when it turned out that the provident funds had lost money in the first half of that year, after doing badly in 1995 and losing money in 1994 as well.

Sick of it, the public abandoned the provident funds. To give people their money back, the funds had to sell their holdings in government bonds, the price of which promptly tanked. That happens in a glut. Yields rose as high as 4.5%, linked to the consumer price index.

Then the public started to feel that its pension savings were vanishing, and demanded compensation. Those were bad months for bankers, who were under attack. People demonstrated outside the Finance Ministry, demanding action to save their pensions.

After internal squabbles, the Bank of Israel agreed to lay out a safety net - to buy bonds as their price was falling. Thus in July and August 1996 the Bank of Israel bought NIS 1.5 billion worth of bonds, which continued to fall in price. Yields rose to 5.5%. Only then did the banks, insurance companies and pension funds come back to the market and start buying bonds. And then the Bank of Israel stopped intervening and the crisis ended.

Which all goes to say that intervention can be okay. It all depends on when. Today's stock market crash isn't about Israeli government bonds. They're doing fine. The public continues to believe in the state, that the Israeli government will return its debt.

The problem is that the public doesn't believe the tycoons - Leviev, Tshuva and Fishman - can return their debts.

When government bonds crash, it is in the public's interest for the state to intervene, to signal that it will meet its liabilities.

When corporate bonds crash, there's no cause to intervene. It's just that the risks the tycoons took are materializing.

There is no reason for Yossi and Smaddy Kol-Echad to fork over cash to save the tycoons and the people who bet on their shares and bonds. In addition, every shekel the state spends on bailing these people out is money not spent on the old, sick and children.